Towards an economic turnaround?

Is the economic turnaround round the corner? Well, the go-ahead given by the International Monetary Fund executive board to the release of $501.4 million to Pakistan, as part of a three-year credit arrangement, may suggest that the efforts to put the economy back on track are cruising well. Yet an affirmative answer to the question on the basis of the green signal from the multilateral donor would amount to jumping the gun.
If one word were to be used to sum up Pakistan’s economic predicament over the last several years, it would be ‘stagflation’ – low growth coupled with high inflation. Between FY09 and FY14, the real domestic output expanded on average by only three percent, while the average annual inflation as measured by the consumer price index (CPI) was 11 percent.
Stagflation is a hard nut to crack in that it combines two phenomena which as a rule run counter to each other. In normal circumstances, policymakers can choose between higher output and lower prices. But when an economy has to both drive up the growth rate and put the brakes on inflation, it doesn’t have the luxury of this trade-off. This dual aspect of stagflation leaves economic managers with a rather narrow range of options to shape up the economy.
The present government, like its predecessor, started off by knocking at the door of the IMF for assistance. The Fund agreed to provide $6.12 billion in credit under the Extended Fund Facility over three years starting September 2013. The EFF is designed for the economies facing low growth and an inherently weak balance of payment (BoP) position as well as those suffering structural impediments. Pakistan, evidently, fits both these descriptions.
Some hiccups apart, the programme with the IMF is going on smoothly ushering in the approval of the seventh tranche to Pakistan and bringing the total credit disbursed under the arrangement to $3.5 billion. The Fund’s press release dated March 27, 2015 notes that “Progress has been made in restoring economic stability, improving growth prospects, and reducing crisis risks.”
The Monetary Policy Statement (MPS) issued by the State Bank of Pakistan on March 21, 2015 also paints a fairly rosy picture of the economy. For the current fiscal year (FY15), the central bank predicts both the growth rate to be higher and inflation to be significantly lower than that in the preceding year – the optimism is cautiously shared by the Asian Development Bank. This suggests that the economy is slowly coming out of stagflation.
Be that as it may, are some other key indicators looking up? Take savings and investment. Pakistan has had low savings-to-GDP and investment-to-GDP levels, which have further come down over the years.
Between FY09 and FY13, the average savings-to-GDP and investment-to-GDP ratios were 12.8 and 15.4 percent respectively. In FY14, the percentage share of savings and investment in the total output was 12.9 percent and 14 percent respectively compared with 13 percent and 14.6 percent respectively a year earlier. It will be a big challenge to meet the FY15 targets for savings (14.6) and investment (15.7).
As per World Bank data, Pakistan’s investment-GDP level is one of the lowest among the developing countries and the lowest in South Asia: India (35), Bhutan (56), Sri Lanka (30), Bangladesh (27), and Nepal (35).
Maintaining fiscal balance has been a big challenge for the government. Between FY09 and FY13, on average, the fiscal deficit constituted 7 percent of GDP. During FY14, the fiscal deficit was brought down significantly to 5.5 percent from 8.2 percent a year earlier. During the first half of the current fiscal year, fiscal deficit as percentage of GDP was 2.2 against the full year target of 4.9 and compared with the FY14 corresponding period figure of 2.1.
The share of taxes in the total output continues to cut a sorry figure. Between FY09 and FY13, the average tax-to-GDP share was 9.6 percent including 9.8 percent for FY13. In FY14, the share went up marginally to 10.1 percent.
Pakistan’s is among the lowest tax-to-GDP ratios in the world and the second lowest in the region: India (17.7), Bhutan (10.7), Sri Lanka (15.3), Bangladesh (8.5), Nepal (10.9) and the Maldives (20.5). Tax evasion is strongly embedded in the national culture and it is only the salaried class that pays full taxes and that too because their contribution is deducted at the source.
Like broadening the tax base, shaking up the loss making public sector enterprises has turned out to be elusive. The planned sale of some of the PSEs has given rise to stiff political opposition. As a result, the restructuring/privatisation of these enterprises hangs in the balance.
It was a difficult BoP position that forced Pakistan to go for IMF assistance in 2013. At the end of FY12, the net foreign exchange reserves available with the central bank had come down to $5.5 billion from $10.15 billion nearly a year earlier. The current account deficit and trade deficit made up 2.4 percent and 6.7 percent of GDP respectively.
The following two years saw an improvement on the external front as current account deficit fell to 1.1 percent of GDP in FY13 before going up marginally to 1.3 percent of GDP in FY14. In the first eight months of the current fiscal year, the current account deficit made up 0.8 percent of the GDP.
On the whole, the BoP situation has eased and foreign exchange reserves available with the SBP reached $11 billion (as on March 20, 2015). But the recovery is precariously placed as it has a lot to do with lower oil prices, foreign assistance and remittances from Pakistani expatriates. External debt and liabilities stood at $63.33 billion at the close of 2014.
Between FY09 and FY14, merchandise exports grew cumulatively by 41 percent bringing the average annual export growth to nearly 7 percent. In FY14, exports surpassed $25 billion for the first time. Between July and February FY15, the country exported $16 billion worth of goods.
The export base continues to be narrow – only three product categories, cotton manufactures, leather and rice, account for 66.5 percent of total exports – and exports are dominated by primary products and semi-manufactures. For sustained export growth, such structural constraints need to be addressed.
FDI inflows have dried up. Between FY09 and FY14, the country received FDI of $1.9 billion a year on average. In the first eight months of the current fiscal year, FDI of $616 million was recorded. Pakistan may present the most liberal FDI regime in the region but several factors, at the top of which is the precarious security situation, have held back FDI.
One big factor that has sustained the economy over the years is remittances. Between FY09 and FY14, remittances more than doubled to reach $15.8 billion. In the first eight months of FY15, remittances worth $11.75 billion were received.
It follows from the foregoing that on the whole the economy is beginning to look up. However, an economic turnaround is still a long way away. Political stability, the security situation and the supply-side – including energy – situation are the three foremost factors that will affect the efforts for economic revival.
The author is a graduate from a western European university. Email: hussainhzaidi@gmail.com